Financial markets depend on efficient execution of trades to buy and sell equities. Historically, human traders executed the trade with one trader representing the seller (the “sell-side trader”) and a second trader representing the buyer (the “buy-side trader”). As trading volume increased, more trading was performed automatically by computerized systems, such as the NASDAQ marketplace and ECNs (Electronic Communications Networks). The types of trades have also grown more complex. Today, there are many different types of trades of varying levels of complexity, and equally many diverse trading strategies to execute these trades.
One of the challenges encountered by a buy-side trader is how to choose the right execution strategy from a large number of possible execution strategies. Consider a simple order to buy 2,000 shares of fictitious large-cap XYZ Corp. The trade order is presented on the trader's screen and the trader is immediately faced with many decisions. Should this trade be executed over 30 minutes or 3 days? Should the trader use market orders or limit orders? Does the trader execute the trade as part of a portfolio trade or as a single stock trade? Should the trader use a traditional broker-dealer or direct market access (DMA)? The trader must make many snap decisions, select an execution strategy based on these decisions, and then allow the system to complete the trade.
Efficient trade execution thereby requires timely selection and application of the most suitable execution strategy for a particular trade. This is not so simple. Indeed, the problem of choosing an optimum execution strategy gets very complicated, very quickly. In a rapid trading environment, the trader commonly sees a large volume of trades flash across the screen. The trader is forced to make execution decisions in a very short timeframe. Further, each execution decision has a real cost associated with it. For instance, if the trade order is difficult, there is a preference for a “high touch” strategy that involves a human trader. The human trader charges a higher premium for executing the trade. Conversely, if the trade order is not overly complex, a “low touch” strategy that calls for computerized execution of the trade might be preferred. The cost to execute a trade electronically is generally significantly lower (sometimes orders of magnitude lower) than that involving the human trader.
Accordingly, there is a need for improved techniques to assist traders in making timely decisions to identify appropriate execution strategies that minimize the costs of executing the trade.